Professor of Economics Proposes Retirement Reform

Mounting evidence suggests that reform of both the current
structure and tax-code treatment of retirement accounts could stimulate greater
savings for many Americans, a paper suggests.

In a new Hamilton Project discussion paper, John N.
Friedman, Professor of Economics at Brown University, proposes two related
reforms to the current system of retirement savings accounts.

First, Friedman calls for replacing the current multitude of
retirement savings accounts with a single plan, the Universal Retirement
Savings Account (URSA). Worker’s individual accounts in the plan would stay
with them permanently, following them as they change jobs. This reform would
both decrease confusion about different accounts and reduce retirement savings
leakage that happens when workers change jobs and exercise the opportunity to
cash out their employer-based plans, Friedman suggests.

Second, Friedman proposes redirecting part of the tax
incentive aimed at individuals toward large tax credits for employers who help
workers save through auto-enrollment and payroll-deductible contributions. He
contends that firms are both more knowledgeable about and more responsive to
tax incentives than individuals are, and this shift would increase the
effectiveness and progressivity of such targeted tax incentives.

NEXT: The universal retirement accounts proposal.

In his paper, Friedman says that since employer-sponsored
plans are specific to each employer, individuals—especially if they change
jobs—often must manage a large number of retirement accounts with varying rules
for contributions, withdrawals, and asset management. The federal tax code
currently provides for no fewer than thirteen different types of individually
directed retirement savings accounts, he notes. This complexity, Friedman
asserts, generates needless administrative burden and confusion for both
employees and employers, resulting in lower-quality choices of savings and
asset allocation. The administrative transition from one retirement plan to
another that occurs when workers switch jobs also contributes to the large
amount of early withdrawals from retirement accounts.

With Friedman’s proposal, Congress would replace the
multitude of tax-preferred retirement savings accounts with a single
tax-preferred URSA, which could function under either pre-tax or post-tax
treatment. Existing retirement accounts would be rolled into the URSA as
subaccounts, and account holders would have the option to convert assets into
the main URSA account at any time.

Workers would hold their URSAs at account providers
regulated under a framework similar to that currently governing 401(k) plans.
Eligible assets would exclude speculative and overly risky investments and
would ideally be restricted to low-cost index funds and lifecycle funds.

Fiduciary duty would shift from employers, who often lack
financial expertise, to account providers. For bearing this responsibility,
account providers would be allowed to levy an annual 0.01% fiduciary fee on
account balances.

NEXT: Change in the treatment of tax incentives.

Despite the preponderance of tax-preferred retirement plans,
which continue to grow rapidly in dollar terms, Friedman cites scholarly
evidence suggesting that incentives based on income tax breaks are not
effective at raising savings rates, especially among those who are most in need
of additional saving. First, he says, research shows that roughly 80% to 85% of
savers are unaware of or inattentive to the tax incentives and thus do not
change their savings behavior. Second, savers who do respond to the incentives
do not save more overall but instead shift money they would have saved anyway
to tax-preferred retirement accounts.

Third, according to Friedman, research has shown the savers
who respond the most to tax incentives tend to be wealthier individuals who are
already saving enough for retirement. Two-thirds of the current tax break goes
to households in the top 20% of the income distribution, and one-third goes to
those in the top 5%. These inefficiencies suggest the current system can be
reformed successfully to encourage more Americans to save more for retirement,
Friedman says.

Under his proposal, by auto-enrolling their employees into
low-risk, low-fee URSAs, at a set savings rate of at least 3%, employers would
receive refundable tax credits against the employer share of the payroll tax.
The savings rate would increase for workers by 1% annually, up to 8% of pay.
The size of the tax credit would increase with the number of employees at a
slowing rate.

The federal government would offset these employer tax
credits by instituting new limits on tax-deductible contributions to
employer-sponsored savings accounts, including URSAs. If Congress set up URSAs
as pre-tax accounts (like today’s 401(k)s), the cap would be set at $35,000 and
the share of income that can be deducted for tax purposes would be limited to
25% instead of the worker’s marginal tax rate.

If Congress set up URSAs as post-tax accounts (like today’s
Roth IRAs), the cap would be set at $25,000 and withdrawals would no longer be
tax-free but subject to capital gains tax of half the normal rate.

A policy brief summarizing Friedman’s proposals is available here, and the full paper is available here. He will discuss his proposals at an
upcoming policy forum on Tuesday, June 23, at the Brookings Institution, where
U.S. Secretary of Labor Tom Perez will deliver remarks.